Hostess’ failure simmered for years

When Hostess Brands shut its doors last month, the unions and the company pointed fingers and blamed each other.

In reality, while the recent bakers union strike against the company might have been the last straw, the demise of the 82-year-old maker of Twinkies and Wonder Bread had begun a decade earlier.

Additional Photos

Striking workers placed a faux coffin lid outside the Hostess bakery in Biddeford after the company announced last month that it would liquidate. In hindsight, an analyst says, both the union and company would have been better off had they tried harder to reach a deal. 2012 Staff FIle Photo/Gregory Rec

“It’s a little bit of a scapegoat — the union problem,” said Bob Goldin, executive vice president of food industry analysis firm Technomic. “If their business was growing 10 to 15 percent a year, these union problems wouldn’t have been as much of a factor. A growing business would have saved a lot of ills.”

Hostess got final bankruptcy court approval on Nov. 21 to close its 33 bakeries and put its brands up for sale, putting about 15,000 employees out of work. Another 3,200 will be unemployed after they finish closing down the company over the next year.

In Maine, 500 Hostess employees are out of work, including 370 at the Hostess bakery in Biddeford, which produced chocolate cupcakes, Sno Balls and other snack cakes and bread.

The closure ends a decade of financial chaos for a company that has had six chief executives in the past eight years and had to contend with complicated labor agreements, rising commodity prices and a shift in American tastes toward healthier foods. It also operated under inefficient work rules, such as a requirement that cakes and bread be delivered in separate trucks to the same retail location.

Those problems compounded the pressures the company was already facing from a botched reorganization after its first bankruptcy filing in 2004, analysts said.

“With the benefit of hindsight, it’s clear that the company probably should have imposed deeper cuts in the first round. But imposing those cuts often involves a kind of ‘fight’ with creditors that can be costly, so there is often a temptation to ‘kick the can’ and hope it will all turn out OK in the end,” said Stephen Lubben, the Harvey Washington Wiley Chair in corporate governance and business ethics at Seton Hall Law School and a bankruptcy expert. “The unions have taken a lot of blame, but there are some real indications that the company was not too well run after its first bankruptcy case.”

FRESH INFUSION OF MONEY

That reorganization took five years, cut $110 million in annual labor costs, and gave the company a fresh infusion of money. But the revamping left Hostess with more debt than it started with, and it was still saddled it with a cumbersome labor structure — issues that made it inevitable that the company would return to bankruptcy court, experts said.

Even though the company got some union concessions during its first reorganization and cut 10,000 jobs, its labor issues remained overwhelming: Its work force was 83 percent unionized and the company had to negotiate with 12 separate unions. Its 372 collective-bargaining agreements required Hostess to maintain 80 different health and benefit plans and 40 pension plans. Its three dozen bakeries served 5,500 delivery routes and 500 distribution centers.

NOT KEEPING UP WITH TASTE TRENDS

The company also failed to keep up with trends in American tastes.

“In the snack business, they hadn’t done anything to grow that business,” Goldin said. “No marketing. No innovation. It’s the same darn products they’ve had for generations. The same cakes, the same flavors. It’s the same old, same old. They were riding on momentum and their audience is old — the people who grew up eating these products. And they haven’t bought one in years.”

Analysts joked that Hostess’ last major product introduction came in 1967 when it introduced Ding Dongs and Ho Hos. Wonder Bread had been the first large-scale baker to sell loaves of presliced bread, but that innovation came in 1930.

STILL USING TWINKIE THE KID

Hostess’ marketing was also outdated. Its best-known advertising campaign was in the 1950s when it sponsored television show “Howdy Doody.” Its perennial mascot was a bandana-and-cowboy-hat-wearing snackcake called Twinkie the Kid, who was born in 1947 and hadn’t changed since.

Still, the Twinkie retained an iconic role in the American lexicon: In 1979, the term the “Twinkie defense” was coined during the trial of Dan White, who binged on junk food — which he claimed diminished his mental capabilities — before killing San Francisco Mayor George Mosconi and supervisor Harvey Milk in their City Hall offices.

So what went wrong for Hostess?

Hostess was carrying about $450 million in debt when it filed for its first bankruptcy in 2004. The debt was owned by Silver Point, Monarch and about 20 other lenders.

Throughout its five-year restructuring, Hostess managed to cut labor costs and get an infusion of $130 million from private equity firm Ripplewood Holdings, as well as a secured loan of about $360 million from its lenders.

Lenders also agreed to forgive half of Hostess’ $450 million debt and exchange the other half for payment-in-kind loans with high interest rates.

OFFER TO BUY IS REJECTED

At one point in its reorganization, Hostess had the chance to be acquired in a $580 million bid from a group that included rival Bimbo Bakeries USA, a unit of Grupo Bimbo of Mexico, and supermarket giant Ron Burkle. The offer was rejected in 2007.

The company emerged from bankrutpcy in 2009, changed its name from Interstate Bakeries Corp. to Hostess Brands and received an infusion of $490 million in funds. But its debt load had actually risen to $670 million — higher than when it filed for bankruptcy.

The company also emerged from bankruptcy during the recession, as commodity prices for ingredients such as wheat, sugar and flavorings were rising and consumers were becoming more price conscious and less brand-loyal, analysts said.

“The industry has been challenged by rising commodity costs. There’s a delicate balance in managing the impact of cost pressures without passing on those prices and causing negative sales volumes,” said Morningstar equity analyst Erin Lash.

Hostess’ sales shrank at a time when its rivals were getting stronger and scooping up other assets. In 2011, Grupo Bimbo bought Sara Lee, while Flowers Foods bought Tasty Baking Co.

SNACK SECTOR WAS GROWING

Hostess still had an opportunity to recapture a segment of the market: While the bread industry was stagnant, the snack sector was becoming the fastest growing segment of the food industry. But Hostess failed to capitalize on that demand, analysts said.

“Among the bakeries, price rather than brand drove customer purchase choices. In the snack area — which is the fastest growing segment of the food industry — convenience and consumers’ constrained budgets helped drive sales. Consumers are financially constrained so they’re snacking more as a treat than going out to lunch,” Lash said.

“There’s been an increased emphasis on product innovation — reduced calorie packs, variation of products. Product innovation that resonates with the consumers is what drives incremental category growth. For a lot of companies, price is just one of the levers they have — they adjusted packaging sizes, used different ingredients, introducing new varieties.”

Hostess, however, took none of those steps.

MORE CASH, NO RESULTS

As the company burned through its cash, Ripplewood put up $40 million in exchange for a bigger ownership stake and a bigger piece of its debt. Silver Point, Monarch and other lenders coughed up another $30 million in August 2011 to try to avert another bankruptcy filing.

It didn’t work. Hostess filed for bankruptcy in January 2012 with $860 million in debt. Its net loss ballooned to $1.1 billion in fiscal 2012 on revenues of $2.5 billion. By contrast, sales in 2002 had been as high as $3.5 billion. The company also had about $110 million in unfunded pension obligations.

Hostess had been hobbled by rising commodity prices, industry consolidation by its rivals, shrinking sales due to changing habits on the part of diet- and budget-conscious consumers, as well as a lack of marketing muscle. Its unions contended it also had failed to modernize many of its factories or maintain its trucks.

After its second bankruptcy filing, lenders poured in another $75 million to keep the company afloat. Hostess again sought additional wage and benefit concessions from its unions, a tough battle considering the company had asked for concessions already in its first bankruptcy reorganization. Hostess also had stopped contributing to its union pension plans more than a year ago.

BAKERY UNIT REJECTS CONTRACT

Unions countered that Hostess had approved pay raises for its top executives, belying the company’s claims of commonly shared sacrifice.

While the Teamsters eventually agreed to the concessions, which included up to 32 percent in wage and benefit reductions, the bakery union balked. In September, 92 percent of the bakery unit voted against Hostess’ final contract offer.

With the bankruptcy court’s blessing, Hostess imposed the cuts on its workers, prompting the Nov. 9 strike by the bakery union. A week later, the company shut its doors.

Hostess CEO Greg Rayburn has suggested that the bakery union sacrificed the workers in an effort to produce a show of force at other unionized companies. The union in turn blamed the company for mismanagement and enriching executives and owners rather than investing in the company and its brands.

“There was a game of chicken played between the unions and the private equity owners here. And likely both would have been better off by reaching a deal,” Seton Hall’s Lubben said.

MANAGERS TO GET BONUSES

Hostess on Thursday got approval to pay $1.8 million in bonuses to 19 managers who will oversee the dismantling of the company. The bonuses range from $7,400 to $130,500 and do not include pay for Rayburn, who was brought on as a restructuring expert earlier this year. Rayburn is being paid $125,000 a month, or $1.5 million a year.

“Hostess failed because its six management teams over the last eight years were unable to make it a profitable, successful business enterprise. Despite a commitment from the company after the first bankruptcy that the resources derived from the workers’ concessions would be plowed back into the company, this never materialized,” said Frank Hurt, president of the bakery union.

“Management refused to invest in modernizing its bakeries or devote necessary resources to advertising and marketing, product development and new technology. Business plan after business plan failed, leaving the company ever

Joshua Scherer of Perella Weinberg, who was hired by Hostess to sell its assets, told the bankrutpcy court that calls from potential bidders, including large national retailers and overseas buyers, were coming “fast and furious.”

The liquidation could raise $1 billion, Scherer estimates.

Analysts say whoever buys the company would be smart to pick up snack brands such as Twinkies and Drake’s, but bypass Wonder Bread.

“The snack business can be resurrected, not the bread category,” Goldin said. “It’s not perceived to be high quality.”

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